ELEC2 - Module 7 - Other Concepts and Valuation Techniques

CHAPTER 7
OTHER CONCEPTS
AND VALUATION
TECHNIQUES
This Photo by Unknown Author is licensed under CC BY-SA
Department of Accountancy – MGT7A-Financial Management

LEARNING OUTCOME
• Define due diligence
• Enumerate the types of due diligence
• Enumerate the factors to be considered in the due
diligence
• Define mergers and acquisition
• Enumerate the major valuation used in mergers and
acquisition
• Define divestiture
• Enumerate the types of divestitures
• \enumerate other valuation techniques
Department of Accountancy – ELEC2 –Valuation Concepts and Methods
Source: Valuation Concepts and Methodologies
By: Marvin V. Lascano, Herbert C. Baron and Andrew Timothy L. Cachero
LEARNING CONTENTS
• Due Diligence
• Mergers and Acquisition
• Divestitures
• Other Valuation Techniques

DUE DILIGENCE
• In the initial chapters, valuation techniques facilitate the
process of determining the value of an asset or an
investment. In practice, especially those who will be doing
their initial private offering provide for investment
prospectus that serves for the reference of the investor on
how the fund will be distributed or used from this the
investor will have the more or less an idea on what the risk
he or she is about to face.

DUE DILIGENCE
• In order to minimize the investment risk, due diligence is
undertaken after the intent to purchase or invest in a company.
Due diligence is a process of validating the representations
made by a seller, normally to an investor. This process would
require thorough examination of all records that would be
relevant in the realization of returns or the so-called advertised
benefits. Some investors would procure the services of an audit
or forensic accountants to determine and validate the inputs
used in the determination of the value or whether there would
be some information that may pose the risk in the realization
of the perceive returns. The due diligence team is composed of
lawyers, auditors and technical experts. Other than the
inspection and audit of records, actual field or site inspection is
also taken.
DUE DILIGENCE
• Due diligence was started to be a formal exercise since the
mid 1900. In the United States of America. The Securities
Act of 1933 requires full disclosure of information from the
dealers and brokers, this provides protection to the
investors in engaging with any concealed information that
would impair the value of the investment. Penalties and
sanctions were imposed by the law. This is to protect the
investors at the same time the economy that due to
information or potential risks that were not disclosed may
result economic sabotage.
DUE DILIGENCE
• In the Philippines, Republic Act 8799 or the Securities
Regulation Code which serves as the equivalent regulation
that protects investors in the country. This law is actually
the charter of the Securities and Exchange Commission or
the SEC. The law enumerates the information that needs to
be disclosed by companies and the frequency to enable
the commission to monitor the operations of the
partnerships and corporations in the Philippines. Certain
penalties were imposed by the law for noncompliance with
the requirements set.
TYPES OF DUE DILIGENCE
• Due diligence varies and designed according to the size and
nature of the investment. The exercise maybe categorized
into who conducts the process and what is the nature of
the prospective investment,

• Due Diligences According to the Executor
➢Corporate Due Diligence
If the due diligence exercise is to be conducted or
commissioned by a company or corporation that will invest
to business this is considered as Corporate Due Diligence.
The corporate due diligence normally commissioned
external experts such as technical experts, lawyers and
auditors, since companies do not consider this exercise as
their core function. The cost of the company, given that
the investments entered by corporations are significant it
is fitting to incur costs rather than impairing the value of
the investment in the middle of the operations.
➢Private Due Diligence
If the due diligence exercise is facilitated or conducted by
individual or at least few individual investors but is not yet
incorporated this is called private due diligence. While the
broker-dealers are legally mandated to conduct due diligence on
a security before they bring the investment into the market,
individual investors still would require due diligence for the value
that they initially calculated. Normally, private due diligence was
done by the investors themselves since most of them are not
capable of forming or hiring a team. In most cases, private
investors are less aggressive than the corporations. Although due
diligence team can still be constituted, but for as long as the
engagement is with a private individual is considered private due
diligence.
➢Government Due Diligence
In some cases, government needs to do due diligence
either for investment or regulatory purposes. If the
due diligence is commissioned or conducted by the
government, it is called as government due diligence.
Most of the time, this type of due diligence is for the
protection of the public or evaluation of the operations
of the company for the public interest.

• Due Diligences According to Subject
➢Hard Due Diligence
When the due diligence focuses on the data and hard
evidential information this is called hard due diligence.
Hard due diligence is where the lawyers or legal team,
accountants, and deal facilitators are actively engaged.
Normally, hard due diligence focuses on earnings before
interest, taxes, depreciation and amortization (EBITDA),
the aging of receivables, and payables, cash flow, and
capital expenditures. Intellectual property and physical
capital are also focus, particularly for subject companies
belong to sectors such as technology or manufacturing.
➢Hard Due Diligence (cont.)
Driven by mathematics and legalities, hard due
diligence is prone to unrealistic and biased
interpretations by eager salespeople. Soft due
diligence acts as a counterbalance when the numbers
are being manipulated or overemphasized.

➢Hard Due Diligence (cont.)
Examples of hard due diligence activities include:
oReview and audit of the financial statements
oValidation of the projections for future performance
oAnalysis of the market or industry where the subject
company belongs
oReview of operational policies, process and procedures
oReview of potential or ongoing litigation
oReview of antitrust considerations
oAssessment of subcontractor and other third-party
relationships
➢Soft Due Diligence
Soft due diligence focuses on the internal affairs or the
internal organization of the company and its
customers. So essentially, this type of due diligence is
designed to validate the qualitative factors that affect
the realization of returns, which measurement cannot
be normally done by use of mathematical calculation
and therefore harder to conduct compared to hard due
diligence which concentrates to verifiable data.
➢Soft Due Diligence (cont.)
Most of the time the Hard Due Diligence is conducted
and focused heavily on the quantitative and economic
drivers of the returns. But recently, soft due diligence
started to be seen with great importance since the
realization of the perceive returns which drives the
value of an investment will be delivered by the
employees and the customers or clients.

The reason why the popularity of the soft due
diligence had traction is that there are some drivers to
enable the business to realize and sustain its returns
were not fully capture through reports and even
contracts, such as employee relationships, corporate
culture, leadership etc. Most failures of the business
are due to inability to validate the integrity of the
internal foundation of the business.
Subcategory of soft due diligence is the Human Capital
Due Diligence. This was introduced in April 2007 issue
of the Harvard Business Review. Human capital due
diligence is focus on assessing the organization,
mission and vision as well as the competencies of the
employees and management of the business. This
sometimes covers even the review of the
competencies of the board of directors.
Soft due diligence is concerned with employee
motivation, and compensation packages are
specifically constructed to boost those motivations. It
is not a panacea or a cure-all, but soft due diligence
can help the acquiring firm predict whether a
compensation program can be implemented to
improve the success of a deal.

Soft due diligence can also concern itself with the
target company’s customers. Even if the target
employees accept the cultural and operational shifts
from the takeover, the target customers and clients
may well resent a change in service, products, or
procedures. This is why many M&A analyses now
include customer reviews, supplier reviews, test
market data.
Examples of soft due diligence activities:
oOrganizational Review including Succession Plans
oCompetency Assessment
oQuality Assurance on Customer Services
oQuality Assurance on Processes
oOn the ground interview and examination

➢Combined Due Diligence
When the focus of the due diligence exercise is to
cover both quantitative and qualitative areas of the
company or business it is considered as the combined
due diligence. It is also known as comprehensive due
diligence.

➢Combined Due Diligence (cont.)
In the combined due diligence is where the hard and soft
due diligence activities intertwine, especially when the
focus of the evaluation will come across the quantitative
impact of those covered by the soft due diligence. For
example, compensation and benefits, retirement
packages, quantitative impact of collective bargaining
agreement, cost benefit analysis of customer service
initiatives etc. These programs are not only based on real
numbers, making them easy to incorporate into post-
acquisition planning but they can also be discussed with
employees and used to gauge cultural impact.
FACTORS TO BE CONSIDERED IN
THE DUE DILIGENCE PROCESS
• Based on the foregoing discussions, the due diligence
process varies from an investment prospect to another.
There are various strategies on how the due diligence
process was administered. The process would also be
affected by the factors or the elements that would affect
the investors decision to proceed with the investment or
not.

• Market Capitalization
The company’s market capitalization or total value
provides an indication on how volatile the value of the
company in the market. Recall that the market
capitalization when divided into the number of
outstanding shares is the market value per share. This
represents on how broad its ownership is and the
potential size of the company’s target markets.

• Market Capitalization (cont.)
The market capitalization is also used to categorize the
companies in terms of its volatility. The Philippines Stock
Exchanges observe 3 categories of market capitalization
e.g. Large-cap, Mid-cap and Small-cap. Large-cap
companies tend to have stable revenue streams and a
large, divers investor base, which tends to lead to less
volatility. Mid-cap and small-cap companies typically have
greater fluctuations in their stock prices and earnings
than large corporations. In some countries, they also have
Mega-cap which has larger values than large-cap.
• Performance/Profitability Trend Analysis
The historical performance and trend of the company
would add more integrity on the realization of the future
earnings. The results of the performance and profitability
trend analysis may provide sufficient data for the
projection. Some analysts use regression line analysis to
some project the future cash flows based on the historical
trend. Some of the focus of the performance are revenue
growth, net income growth, net income margin, EBITDA
margin, return on invested capital, return on total assets
etc.
• External Environment Analysis
Assessing the position of the company in the industry is
also a good input to the due diligence exercise. It is
believed that industry benchmarking would allow the
analyst to decipher how the target investment fair with
the other players in the industry. This may address the
question – Are the variables inputted in the valuation
relatively the same with the other industry players?

• External Environment Analysis (cont.)
By looking into the comparable companies will enable the
validation process, this is because if the companies used
as index in the market can perform the same level
assumed in the valuation then it is highly probable. This
also involves scanning the market forces that may have an
impact to the business. A sound test is to validate that
factos impact to the company for 5 to 7 years.

• Management and Share Ownership
Assessment of the personalities involved in the governance
and policy making of the company is also critical. Their
leadership style may serve as a reference for the analyst or
investor to assess the integrity of the initial valuation. Newer
companies tend to be founder-led. It may be helpful to
conduct research on the background of the members of the
management team to find out their level of expertise and
experience. This is why most companies, especially publicly
listed companies, has to post the profile of the members of
the board in their annual reports, company website and other
official channels of the company.
• Management and Share Ownership (cont.)
Also, it would be helpful to understand the percentage of
share of each member of the board and whether they
have been selling shares recently. High ownership by top
managers is a plus and low ownership is a red flag.
Shareholders tend to be best served when those running
the company have a vested interest in the performance of
the stock.

• Financial Statements
The financial statements serve as the best document to
support the financial performance and financial position
of the company including their cash flows. Careful
scrutiny of the contents of the financial statements
particularly the notes to the financial statements because
it provides information on how the company is seeing its
future.

• Stock Price History
Similarly, investors should do the same to analyze stock price
history. Investors should research both the short-term and
long-term price movement of the stock and whether the
stock has been volatiles or steady. Compare the profits
generated historically and determine how it correlates with
the price movement. Keep in mind that past performance
does not guarantee future price movements. If you’re a
retiree looking for dividends, for example, you might not want
a volatile stock price. Stocks that are continuously volatile
tend to have short-term shareholders, which can add extra
risk factors for certain investors.
• Stock Dilution Possibilities
Related to the analysis of stock price history, investors
should know how many shares outstanding the company
has and how that number relates to the competition. If
the company is planning on issuing more shares, the
stock price might take a hit and hence the possibilities of
stock dilution.

• Market Expectations
Investors should find out what the consensus of market
analysts is for earnings growth, revenue, and profit
estimates for the next two to three years. Information
may be available free in finance websites or from
investment banks or other financial institutions providing
those services. Investors should also look for discussions
of long-term trends affecting the industry and company-
specific news about partnerships, joint ventures,
intellectual property, and new products or services.
• Long and Short-term Risks
The main objective of due diligence is essentially risk
management. Hence, an important part of the process is
taking into consideration the long and short-term risks.
Make sure to understand both the industry-wide risks and
company-specific risks. Example of risks are outstanding
legal or regulatory matters, unstable management,
movement of interest rates, product quality, market
perception, among others. Investors should keep a
healthy attitude of professional skepticism at all times,
picturing worst-case scenarios and their potential
outcomes on the stock.
MERGERS AND ACQUISITION
• Mergers and acquisitions (M&A) is a corporate strategy
that allows accompany to combine its assets to another
company or to acquire another company. Merger is when
two companies combine to form another company. On the
other hand, acquisition is taking over or taking a part of a
company. While, in the case of merger it seems that the
share in interest of two companies are equal though it is
not. For instance, in 2013 the Philippine National Bank
(PNB) and Allied Bank announced its merger, though in the
end it is PNB who became the surviving company. This is
why to avoid issues on what to call a business combination
strategy it is called M&A.
• M&A became a popular business strategy for some
companies to expand and for other to save from distress.
In M&A, it allows the company to increase its revenue to
cover for the expenses, especially the fixed costs, or
increase its asset base or even capture a market share or
control the supply chain.

• The following are the top reason why companies entered into
M&As:
oManage the cost capital
oExpansion and growth
oEconomies of scale
oDiversify for expanded market coverage
oWiden access in the industry
oTechnological advancement
oTax management strategies
oLegal strategies
oControl over supply chain
• In M&As there should be a (1) company must be willing to
take the risk and vigilantly make investments to benefit
fully from the merger as the competitors and the industry
take heed quickly; (2) multiply bets must be made to
maximize the opportunities available; and (3) the acquiring
firm must be patient in the realization of its investment.

• M&As According to Form
M&As maybe classified according to how they are
formed. It is either through absorption or through
consolidation. M&A by Absorption is done when a
company takes over another company, normally the alter
are in a more disadvantageous position. This is like when
Philippine Long Distance Telephone Inc. absorbs Digitel
Telecommunications Philippines.

• M&As According to Form (cont.)
M&A through consolidation is when tow companies
combined its assets and/or restructure their debt profile.
Most of the M&A through consolidation are done by
financing institutions like banks. In 2019, Banko Sentral ng
Pilipinas has announced its plan to launch programs that
will encourage more mergers through consolidation
among rural banks.

• M&As According to Economic Perspective
M&A classification may also be dependent on its
economic perspective. These M&As may be classified into
horizontal, vertical or conglomerate. Horizontal M&As is
when two firms in the same industry combined. An
example of this is in 2000, when Jollibee Foods
Corporation acquired Chowking Food Corporation. These
two are players in the fast food industry.

• M&As According to Economic Perspective (cont.)
Vertical Merger is when two companies merged coming
from different stages of production or value chain. These
occurs when a supplier purchased its customer or vice
versa. Conglomerate on the other hand are M&As from
completely unrelated industries.

• M&As based on Legal Perspective
M&As can also be classified according their legal
perspective like Short-Form M&As, Statutory M&As and
Subsidiary M&As. Short-form M&As is when parent
purchase more interest from its subsidiary. Normally a
parent companies that has about 90% ownership to 100%
is a Short-from M&A. Although in the case of Jollibee
Foods Corporation (JFC) and Greenwich Pizza Corporation
(GPC). JFC has 80% ownership in GPC but decided to buy-
out their partner Green Foods Franchising in 2004 and
changed the name of GPC to Fresh N’ Famous Inc.
• M&As based on Legal Perspective (cont.)
Statutory M&As is when a company combines with
another where the company, the acquirer, retains its
name. In 1999, Far East Bank and Trust Company merged
with Bank of Philippine Island (BPI). Today, BPI is the
surviving company after the statutory merger.

• M&As based on Legal Perspective (cont.)
Subsidiary M&As is the consolidation of the subsidiaries
of a holding or a parent company. An instance in 2006,
where Chowking Foods Corp, Greenwich Pizza Corp and
Baker Fresh Foods Philippines – subsidiaries of JFC
merged into Fresh N’ Famous Foods Inc. and became the
second largest food service in the Philippines in that time.

FIVE STAGES OF M&A
1. Pre-acquisition Review
The first step is to conduct internal evaluation with
regards to the business opportunity. This may require
initial valuation based on ballpark figures. This will
establish whether an investment opportunity is palatable
and worth the investment.

FIVE STAGES OF M&A
2. Investment Opportunity Scanning
If found to be attractive, the second step is to scan the
opportunity for any potential or interest parties. Chances
if there are other potential parties interested with the
M&As it is a signal that is worth the investment. This
stage is also an opportunity to gather risk indicators that
surrounds the business opportunity. In this stage, due
diligence may already begin.

FIVE STAGES OF M&A
3. Valuation of Target Investment
Once additional relevant information was gathered, a
more comprehensive valuation and sensitivity analysis
should be conducted. The value of the offer must be
relevant, realistic and reasonable. In some cases, further
due diligence is also taken place and further analysis is
involved. Some investors require the need to do
discounted cash flows analysis to validate their ballpark
estimate.

FIVE STAGES OF M&A
4. Negotiation
This is the part where the through business comes in. The
companies will have to find the common sweet spot i.e.
the selling company must know how much to sell and the
other how much to buy. It should be noted that in order
for the negotiation to succeed each party must give in
something. This is where the sensitivity analyses will be
given better value and importance since the investor or
seller will know how much price they are willing to give or
receive and how much risk are they willing to take.
FIVE STAGES OF M&A
5. Integration
The final stage is the actual integration of the companies.
The execution of an agreement and reincorporation is
needed. For listed companies certain protocols are
needed to be observed like disclosures, proper
notification to Philippine Stock Exchange and Securities
and Exchange Commission etc.

CONSIDERATIONS TO MAXIMIZE M&A OPPORTUNITY
In evaluating an M&A opportunity, most analysts or
investors observe certain signals that would enable them to
make proper recommendation or decision to pursue an
M&A opportunity.
• Determine objective behind the acquisition and the
benefits expected by both acquirer and target company
from the deal.

• Understand industry of both acquirer and target.
Horizontal integration occurs if the acquirer buys another
company that plays the same role in the industry’s value
chain. Horizontal integration normally happens when an
acquirer buys a competing firm. Vertical integration
happens when the acquiring company buys another
company that is vertically related to them in the value
chain (i.e. a supplier or a buyer). For example, a company
that manufactures car buys a target firm that supplies tires.

• Identify key operational advantages of acquirer and target
company. It is interesting to identify how each firm can
complement each other to improve synergy. For example, the
acquiring company might have strong research and
development (R&D) capability while the target company has an
efficient distribution network in place.
• Check with the acquirer if the takeover is friendly or hostile.
Hostile takeover occurs when the current management
opposes the deal. Current management may prevent access to
information in hostile takeovers which increases the risk of
overpayment as the acquirer may have limited information
used valuing the business
• Analyze pre-merger operating and financial performance of
acquirer and target company through key ratios such as
return on equity, gross profit margins, operating expenses
% to sales and working capital metrics. This will give an
idea which opportunities can be explored to create more
value.
• Evaluate tax position of both companies and determine if
there are net operating loss carry forwards and deferred
tax assets in their books.

REASONS FOR THE FAILURE OF M&A
Like any other business strategies, not all opportunities
succeed. There are also times that M&As fail to realize the
perceive returns.
• Poor Strategic Fit
This is when companies that entered into M&A failed to
find a ground to align their mission, vision and more
importantly their goals. This happens when instead of
strategically reaping more returns it will be diluted by the
higher costs because the company keeps on
compensating for the challenges faced between the
merger of another company
• Poorly executed and ill managed integration phase
Integration is the most critical part of the M&A process.
This is the stage as describe in the earlier discussion of
this part, where the inception of all the affairs that will
start the realization of the perceive returns of the
business will take place. Setting the wrong foot may lead
to a cliff.

• Inadequate Due Diligence
Due diligence is the process that validates all the
assumptions and representations. Failure to identify and
validate the solidity of the inputs in the decision-making
process will end up with the risk encountering issues and
unforeseen liabilities. Cost of rectification would be fatal
to the company.

• Too aggressive Projections and Estimates
Even with a solid due diligence and assumptions backed
up by facts, there are risk of over-projection or optimistic
estimates about the sustainability and growth. It will be
unfortunate if the company will not provide sufficient
cushion or provision to absorb these unforeseen risks in
the calculation of the initial investment of future net cash
flows.

MAJOR VALUATION METHODS USED IN M&A
• Usually the valuation process in M&A transaction is
conducted by the two involved parties: the acquiring and
the target companies. These 2 parties by principle have
two opposing objectives i.e. the acquiring company will
want to purchase the target company at the lowest price,
while the target company will want the highest price.
• Thus, valuation is an important part of M&A, as it guides
the buyer and seller to reach the final transaction price.

MAJOR VALUATION METHODS USED IN M&A
• Below are three majors valuation methods that are used to
value the target. All have been discussed in the foregoing
chapters.
➢Discounted cash flows (DCF) method
The target’s value is calculated based on its projected
future cash flows with appropriate discount rate.
➢Comparable company analysis
Relative valuation metrics for public companies are used to
determine the value of the target.
➢Comparable transaction analysis
Valuation metrics for past transactions in the industry are
used to determine the value of the target.

DIVESTITURE
• Divestiture or divestments refer to the disposal of the
assets of an entity or business segment often via sale to
third party. Divesture generally means the sale of any
assets that the company owns but is also used as a term to
describe sale of a non-core business segment. Partial or full
disposal of the business may occur depending on why
management decided to sell.

DIVESTITURE
• Divestiture is also a strategy used in portfolio management
but is used less frequently compared to mergers and
acquisitions. Most people are more familiar with buy-side
transactions but companies are also keen on disposing
non-performing assets or segments in their effort to
increase shareholder value. Divestitures enable companies
to improve cash flows, discontinue operating segments
that are not aligned with the strategic direction of the
company and create additional shareholder value.

DIVESTITURE
• Companies should constantly review performance of firm
assets and business segments in order to determine
whether divestiture is the best option to take to increase
shareholder value.
• When looking at the financial statements of the firms that
formerly owned the divested segment, the sales and/or
profits of the divested segment are presented separately
under a separate section (e.g. Discontinued Operations) up
until the transaction date.

RATIONALES BEHIND DIVESTITURE
• Sell non-core or redundant business segments – This is the
most common reason behind divestitures. Companies tend to
sell non-core segments in order to focus on maximizing
profitability of their core businesses. If there is change in the
parent company’s strategic direction, divestitures may also
occurs to dispose assets that are not in line with the new
strategy.
• Generate additional funds – If the company does not want
additional liability nor equity, they can also opt to divest assets
to generate cash. In some cases, the cash requirements is
needed for new acquisitions and disposing non-core segments
to support this objective can be a feasible option.
• Take advantage of resale value of non-performing
segments instead of incurring losses – If an operating
segment is consistently generating losses, it might be
worth more as a divestment instead of bleeding money in
retaining it.
• Ensure business stability or survival - In periods where the
business face sever financial difficulties, divesting assets
can be a better option that bankruptcy or closure.

• Adapt to regulatory environment – Divestment may also
occur if the regulatory authorities mandate it to improve
market competition. Changes in taxation policies may also
lead to decisions to divest potentially unprofitable
businesses.
• Lack of internal talent – In some instances, the absence of
qualified internal talent to manage a business segment
may result in consistent losses. This can make the segment
a candidate for divestment in the future.

• Take advantage of opportunistic offer from third party-
Unsolicited offers from third party to purchase an asset
from the company can also be a reason for divestment.
Since the asset is not being offered for sale, the selling
company is in better position to negotiate and demand a
higher price.

TYPES OF DIVESTITURES
Divestitures can be done through the following transactions:
a. Partial sell-offs
The divesting company only sells a portion of the business
(an operating segment, subsidiary, product line) in order
to raise funds that can be used to fund growth of more
productive segments.

b. Equity Carve-out
This occurs when an initial public offering is performed
for up to 20% ownership of a subsidiary. The parent
company retains control of the subsidiary from the
remaining 80% shareholding. Carve-outs allows some
level of cash proceeds from the IPO and establishes an
equity market for the shares of the subsidiary. Companies
that do carve-outs often need additional cash and often
faces uncertainty about how much the subsidiary is worth
and what are the plans and timing for the final
separation.
c. Spin-off
A business segment of the parent company is separated and
is made into an independent new company. Shares of the
spin-off company is distributed to the existing shareholders is
the same for both spin-off company and parent company.
In a spin-off, there is no additional cash generated and total
outstanding shares is still the same. Spin-off is recommended
if there are significant tax benefits from the incorporation of a
new entity and there is no urgent need to raise cash. Spin-off
allows the business segment to further unlock its potential by
getting the right focus from the right people. Spin-offs permit
shareholders to own shares in both entities.
d. Split-off
A business segment of the parent company is also
separated and made into an independent entity.
However, shareholders are offered the option to
exchange parent company shares for the new company
shares or just retain company shares.
No additional cash is generated in split-offs, but
outstanding shares are reduced. Split-offs are less
common than spin-offs and is usually employed to adjust
shareholder ownership level in both entities.
DECIDING WHETHER TO CONTINUE,
LIQUIDATED OR DIVEST
• When deciding to divest, three values are compared: goin
concern value, liquidation value and divestiture value.
Going concern value and liquidation value follows the
similar concepts discussed in previous chapters. Divestiture
value refers to the price that the highest bidder is willing to
pay for the investment or asset. Between the three, the
right alternative to pursue is the option which will yield the
highest value to the seller.

DECIDING WHETHER TO CONTINUE,
LIQUIDATED OR DIVEST
• Impact of divestitures to firm value is enumerated below:
oIf divestiture value is same as going concern value,
divestiture will not have impact to the selling company’s
value
oIf divestiture value is higher than going concern value,
divestiture will increase value of selling company
oIf divestiture value is lower than going concern value,
divestiture will reduce value of selling company

OTHER VALUATION TECHNIQUES:
ROI BASED VALUATION METHOD
• Return on investment or ROI measures the earnings
generated by the business in relation to the investment
made to the business. ROI-based valuation method is a
quick computation of company value based on the
investment that the investor is willing to pay for the
business.

• For example, if the business is asking for P250,000 in
exchange of 25% ownership in the business, total company
value can be derived using ROI-based valuation method. To
compute for the value of the company, divide the amount
of ask (P250,000) by the ownership stake (25%). This will
result in a quick computation of business value at
P1,000,000.
• On a practical view, ROI-based valuation can be useful
since they can already get a sense of how much investment
they are okay to place. However, ROI can be very subjective
since it will depend on the market.
• For the above example, let us assume that cost of
investment is only P600,000.00. Therefore, the ROI
expected by the seller (you) is P400,000.00 or 40%
assuming 100% of the company is being sold. Now, the
same ROI of 40% is being maintained here by the seller
(you) when you pitched the price of P250,000.00 for 25%
of the business. This therefore make this approach
subjective. Conversely, the prospective buyer will have its
own independent valuation to validate the price you
pitched.
• With this approach, additional information is still necessary
to convince an investor or buyer of the result. An investor
or buyer will want to know:
➢Length of time to recover the investment
➢The rate of returns based on the expected net income
as compared with the initial amount invested
➢Aggressiveness of the assumptions used and results.
➢Attractiveness of the investment
• At the end of the day, the investor will need to conduct its
own diligence and perform valuation exercise using the
concepts discussed in previous chapters.
DIVIDEND PAYING CAPACITY METHOD
• The Dividend Paying Capacity Method, also called as
Dividend Payout, is conceptually an income-based method
but can also be classified as market approach as it also
considers market information. This method is somewhat
similar to capitalization of earnings method. Instead of
using earnings, Dividend Paying Capacity Method uses
estimated future dividends that can be paid out by the
business. The future dividends are then capitalized using
five-year weighted average of dividend yields of other
comparable companies.
• The Dividend Paying Capacity Method links the relationship
between the following variables:
a. Estimated amount of future dividends that can be paid
out (based on historical earnings and dividend payout
of the business)
b. Weighted average dividend yields of comparable
companies
c. Estimated value of the business

• Capacity to pay out dividends is also linked with liquidity
and should be considered in the analysis. Profitable
companies can still be illiquid as working and fixed capital
requirements may require significant amount of cash.
Without excess cash, the company will not be able to
declare dividends.

• To illustrate, SV Company has a five-year history of
weighted average annual profits of Php500,000. The
weighted average dividend payout percentage of SV
Company over the last five years is 30 percent while
weighted average dividend yield rate of comparable
companies is at 7.5%.

a. Compute for the future annual dividends that can be paid
(capacity to pay out) by multiplying average annual
profits by the dividend payout ratio.
Wtd. Ave Profits x Wtd. Ave Dividend Payout = Future Dividends
Php 500,000 x 30% = Php150,000.00

b. Compute for the value of the company by dividing future
dividends by the weighted average dividend yield rate of
comparable companies at 7.5%
Future Dividends / Wtd. Ave Dividend Yield = Value of Company
Php 150,000 / 7.5% = Php2,000,000.00

• This method is useful in computing the value of companies
that are stable and has history of consistently paying
dividends to their shareholders. This method is preferred in
valuation since it links the market price with how much
shareholders really receive (dividends) as a percentage of
company earnings.

THANK YOU
STAY SAFE
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Department of Accountancy – ELEC2

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CHAPTER 7

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Department of Accountancy – MGT7A-Financial Management

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

Department of Accountancy – ELEC2 –Valuation Concepts and Methods

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Department of Accountancy – ELEC2

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